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Schroders Quickview: Greece to receive pay-as-you-go bailout

A road map to a long-term bailout deal has been agreed, but not without Greece making major concessions.

13/07/2015

Azad Zangana

Senior European Economist and Strategist

Trust is a delicate bond, and once lost, very difficult to repair.

Greek politicians discovered this over the weekend as European leaders demanded the government implements outstanding reforms before a long-term bailout can be discussed further.

Greek loan reliant on reforms

Greek Prime Minister Alexis Tsipras now has until Wednesday to implement a list of reforms, including on tax and pensions, which he had previously rejected, and indeed, encouraged the entire Greek nation to reject in the recent referendum.

If he succeeds in implementing these reforms, and there is a big question on whether he has any legitimacy in accepting these conditions, then a bridging loan will be provided which will see the government through the 20th of July European Central Bank (ECB) debt repayment.

A second set of reforms focusing on the civil service and judicial system must then be implemented by the 22nd of July, in order to unlock another bridging loan, which will cover other payments due in August.

Counting the cost of a bailout

Assuming Greece manages to swallow its pride and adheres to the creditors’ conditions, negotiations will begin on Greece’s third bailout, which will be funded by the European Stability Mechanism (ESM), and is estimated to cost €82-86 billion.

This is significantly higher than the €53.5 billion Tsipras requested last week, partly due to the self-inflicted recession Greece is in, but also due to the need to immediately provide €10 billion to the banking system for recapitalisation.

Another €12-15 billion is being set aside for further banking aid, but by that point, we should see the ECB lift the Emergency Liquidity Assistance (ELA) limits, which should lead to the lifting of capital controls.

In the event of a new bailout being agreed, the ECB may even begin to buy Greek assets under its quantitative easing (QE) programme.

In addition, European and IMF staff would return to Greece to monitor and support the implementation of reforms.

The roadmap for Greece also includes a condition for the sequestration of €50 billion of Greek assets, to be placed in an independent fund for future privatisation.

This has been a sticking point in the past, but it appears that creditors have won a major concession here from the Greeks.

Finally, while the repayment schedule and interest rates of past debt will be reviewed alongside the new bailout, the agreement states that there will be no nominal haircut.

Reducing the likelihood of GREXIT

Overall, the roadmap for a Greek deal reduces the probability of Greece exiting the eurozone from 75% to about 30%.

This still remains high because of the serious hurdles that must be overcome:

The Greek parliament has to approve and implement the pre-bailout conditions in a very short space of time. Parliamentarians are likely to protest against the nature in which they are being forced to legislate. There have already been street protests, angry that Tsipras has gone against the mandate from the recent referendum. His political future must surely be in jeopardy.

The agreement must be ratified by a number of parliaments in member states, including Germany. Germany’s hard-line stance has not only won support from the usual suspects (Netherlands, Finland, Slovakia) but also two less vocal members, Spain and Portugal. There is a risk that Europe is split on this issue, and a bailout is not provided.

Whatever happens with Greece in coming days, the Rubicon has been crossed by Germany this past weekend when Finance Minister Wolfgang Schäuble proposed a Grexit plan as an option to negotiations.

This must now crystallise the risk of a country leaving the euro if they do not adhere to the rules of the monetary union.

Investors will take note and demand adequate compensation from riskier member states.

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Though many of Europe’s major political obstacles have been overcome, events in Spain highlight that political risk continues to simmer under the surface. These risks are contained for now, helped by quantitative easing which is set to continue into 2018.

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